The big question moving forward is will the recent cluster of
Hindenburg Omen (HO) Signals be followed by another substantial
correction? Prior HO events have been a warning sign for investors
to be cautious moving forward. I use the following criteria to
define an HO Signal.
1. The daily number of NYSE new 52 week highs and the daily number of new 52 week lows are both greater than or equal to
2.5 percent of the number of issues traded that day (some use 2.2% or 2.8%).
2. The NYSE Index is greater in value than it was 50 trading days ago
(some use a 10 Week Moving Average).
3. The McClellan Oscillator is negative on the same day.
4. New 52 week highs cannot be more than twice the new 52 week lows (although new 52 week lows may be more than double new highs).
5. Two Signals must occur within a period of 30 Trading Days (some use
only one signal to confirm a Hindenburg Omen).
Keep in mind we
can only calculate Hindenburg Omen Signals back to 1980 since the NYSE
calculated New Highs and Lows differently prior to 1980. After
1980 New Highs and Lows were based over a 52 Week Rolling Period while prior to
1980 New Highs and Lows were not based on a 52 Week Rolling Period.
as I mentioned back in early June one key
aspect that is ignored by investors when dealing with
Hindenburg Omen's is whether the market is overvalued or not. When
you factor in these two additional parameters (Shiller's PE Ratio is at least
"18" the prior month and the S&P 500 is 100% or more
above its 5 Year Low) then the number of signals is reduced to the following
time periods: September 1987, December 1999, October 2000, July 2007,
October 2007, June 2013 and now August 2013.
As you can see since 1980 there have only been "7" HO
Signals when the Shiller PE Ratio was above 18 and the S&P 500 was at least 100%
above its 5 Year Low so it is a rare occurrence. The prior HO
Signals in 2007, 2000/1999 and 1987 were followed by substantial corrections
ranging from 36% to as high as 58%.
If the recent HO Event does lead to another substantial correction
there are a couple of scenario's to watch for. Since the end of World War
2 the S&P has held long term support either at its 200 Month EMA (points A)
or 400 Month EMA (points B). In addition the long term upward trend
line (dashed purple line) connecting the 1932 low with the 1942 low has not been
broken either. Furthermore as you can see there have only been two
occurrences when the S&P has actually dropped below its 200 Month EMA during
the past 70 years (2009 and 1974).
For theoretical purposes let's say the recent high of 1710 was a
top. Currently the 200 Month EMA is in the mid 1120's while the 400 Month
EMA is in the mid 800's. Thus if a larger correction were to develop a
drop back to the mid 1120's would be a 34% correction while a move down to the
mid 800's would be a 49% correction.
Finally the worst case scenario is
that the S&P has formed a large Broadening Top pattern similar to what
occurred from the mid 1960's through the early 1970's. If this pattern
were to play out then an eventual test of the lower trend line (red line) would
occur which would be a 65% correction based on a target near 600. However,
as mentioned above, in order for this to happen the S&P would have to break
below its 400 Month EMA and longer term upward trend line which hasn't happened
in over 70 years.